Dealers Are Reluctant To Fill Limit Orders, Sec Reports

The Problem Appears To Be Worse Among Nasdaq Dealers, The Commission Reported.

May 6, 2000|By New York Times

NEW YORK -- Veteran investors know that, in a stock market as jumpy as this one, limit orders are the only way to trade. Setting prices on trades means investors are less likely to overpay to buy or reap too little on a sale.

But limit orders benefit investors only if their brokerages actually post the orders for others to see. According to a Securities and Exchange Commission report last week, the prompt display of investor limit orders, as required by securities laws, occurs with a distressing haphazardness.

The report is the result of SEC examinations in 1999 at the nation's stock and options exchanges and at various, unidentified brokerages.

Prompt and proper display of customer limit orders is good for investors and bad for dealers, so the reluctance of some firms to abide by the rules is understandable. After all, if a dealer gets a limit order to buy shares at a price slightly below the prevailing market, he can sell shares to the customer at a profit, never allowing another investor, who would be happy to sell his shares for a slightly higher price, to interact with the buyer.

Customer limit orders also narrow the difference between the prices at which a dealer will buy and sell a stock, known as the spread, driving down investor costs. Because this reduces dealers' profits, they have an incentive not to show the order.

The rules surrounding limit orders were enacted in 1996 after the SEC and the Justice Department found extensive investor abuse on the Nasdaq stock market. Four years and more than $1 billion in penalties later, many brokerages still seem to view investor-fairness rules with contempt.

Investors who place limit orders in Nasdaq stocks appear to fare the worst, according to the SEC. Many Nasdaq dealer firms, for one thing, do not have automated systems to handle their customer limit orders. And not surprisingly, when orders are handled manually, the SEC examiners found significant problems. At one large Nasdaq dealer firm, a trader working manually failed to display 83 percent of customer limit orders properly.

Problems arose even among firms with automatic order display systems. One firm employee unplugged the automatic system for its entire Nasdaq trading desk for several months without anyone noticing.

Investors who trade on the New York Stock Exchange do not appear to encounter such difficulties. The exchange said that last December, it handled more than 6 million limit orders. Of those, only 21 were displayed improperly.

Most troubling, perhaps, the SEC's report calls into question whether self-regulation in securities markets works. Because the SEC report doesn't name names, it is hard to tell where investors are safe and where they are sorry. But investors who are unhappy should tell the SEC. The commission says it is going to step up surveillance of limit-order handling.